Revitalizing the institutional roots of Anglo-American corporate governance

Abstract

Over the past three decades, the topic of corporate governance has become an increasingly high-profile aspect of social-scientific scholarship, in both the Anglo-Saxon world and continental Europe. To a significant extent, however, the conceptual boundaries of the corporate governance debate have been set narrowly in accordance with the logic and language of the dominant ‘agency’ paradigm of governance. According to agency theory, the central problem of corporate governance is the question of how to minimize the (harmful) consequences of the separation of ownership and control within public companies first identified by Berle and Means (1932), by reference to competitive market pressures coupled with market-based incentive and disciplinary mechanisms. In this article, we present an alternative interpretation of the corporate governance problem premised on the logic and language of institution rather than the market, which we argue is both more empirically relevant and conceptually defensible than the dominant agency paradigm. To this end, we rely on some fundamental and longstanding doctrines of Anglo-American corporate law in conjunction with recent developments in the economic theory of the firm. According to the proposed ‘institutional’ model of corporate governance, the central governance problem is that of how to exploit, rather than minimize, the (beneficial) consequences of the separation of ownership and control, so as to engender the development of a more sustainable system of governance than that emanating from the free interplay of (stock) market forces. After setting out the key conceptual underpinnings of our revived institutional model, we analyse how worker involvement in corporate decision-making might be advanced as a way of instrumentalizing this framework within firm-level governance practices.

Keywords:

• corporate governance
• Berle and Means
• agency theory
• stock market efficiency
• law
• worker involvement

Acknowledgements

We would like to acknowledge the financial and peer support of the FP6/RefGov initiative, of which our research for this article formed part. We are grateful in particular to the RefGov subnetwork ‘Corporate Governance in the Public Interest’ led by Professor Simon Deakin at the University of Cambridge.

Notes

1. On the difference between external and internal power, see Tsuk Mitchell (2005, p. 187).

2. Our article is primarily concerned with the Anglo-American case. In continental Europe, equity ownership is traditionally more concentrated (see, e.g., Faccio and Lang, 2002). However, the relative decline of block holdings and the growing importance of investment funds in the equity capital of listed companies tend to increase the separation of ownership and control. Accordingly, our analysis also has some important consequences for the continental European model of corporate governance as it is currently evolving.

3. On the concept of financialization generally and its impact on business strategy, see Froud, Johal, Leaver and Williams (2006). On the impact of financialization on corporate governance and global capitalism, see Ireland (2009) and Jacoby (2009).

4. For more details, see Cheffins (2004). For an excellent account of the co-evolution of contractarian theory and shareholder primacy in the US and the UK on, respectively, a conceptual and empirical level, and with particular regard to the implicit political implications of the contractarian paradigm for the legitimisation of prevailing corporate governance structures, see Ireland (2000).

5. On the irrelevance of the concept of ownership generally as a normative justification for shareholder primacy within public companies, see Dahl (1985, pp. 62–83), Ireland (1999) and Stout (2002, pp. 1190–2).

6. On this, See alo Berle (1932).

7. For this criticism, see, e.g., the special issue (vol. 26) of the Journal of Law and Economics, published in 1983. More recently, see, e.g., Meese (2002). For more details on this issue, see Tsuk Mitchell (2005, p. 212).

8. For an early, original contribution along this line, see Gilson and Kraakman (1984).

9. The importance of the board in shaping the overall quality of public company reporting is regularly reaffirmed by the Securities and Exchange Commission (Brown, 2004), whose primary function is to ensure adequate disclosure. A conspicuous example is provided for by the W.R. Grace Report (1997) – a section 21(a) report – which notes: ‘the Commission considers it essential for board members to move aggressively to fulfil their responsibilities to oversee the conduct and performance of management and to ensure that the company's public statements are candid and complete’.

10. Directorial independence is usually deemed to have been compromised if the director of a company (1) is, or has been, a corporate executive of that company or any of its affiliates, (2) is, or has been, employed by that company or any of its affiliates, (3) is employed as an executive of another company where any of that company's executives sit on the board, (4) is a large block-holder of that company and/or (5) has a significant business relationship with that company or any of its affiliates.

11. Measurements on US data suggest that, in the early 2000s, private investment in intangibles roughly equalled investment in tangibles, representing around 10 per cent of domestic output (Nakamura, 2003; Corrado, Hulten & Sichel, 2006). Intangibles refer here to spending on information and communication technologies (ICT), spending on R&D and patents, spending on development of brands, spending on workforce training in firm-specific capabilities and improvements in labour organization.

12. Empirical literature provides for numerous examples of complementarities in the case of intangible resources. Regarding ICT and new work practices for example, Bresnahan, Brynjolfsson and Hitt (2002) observe that ICT have a stronger impact on productivity in firms that adopt decentralized labour organization at the same time. Regarding training and new work practices, different studies also provide evidence of a correlation between training efforts and labour reorganization, suggesting that their joint combination does improve performance (see, e.g., Lynch & Black, 1998).

13. For more details on this point, see Moore and Rebérioux (2010).

14. For example, in what is arguably the most influential modern account of the US corporate law system, Harvard Law School's Robert Clark explains that, since ‘it is the shareholders who have the claim on the residual value of the enterprise, that is, what's left after all definite obligations are satisfied’, it follows that ‘the managers have an affirmative open-ended obligation to increase this residual value’ (Clark, 1986, pp. 17–18). A recent academic account of the legal features of UK corporate governance, meanwhile, proceeds on the premise that ‘[g]enerally speaking, Anglo-American corporate law embraces a principle that has been expressed in one of the following ways: shareholder primacy, shareholder wealth maximisation or shareholder value’ (Keay, 2007, p. 656).

15. Our references in this article to Delaware corporate law as a general proxy for US corporate law generally reflect the fact that the vast majority of US public corporations choose Delaware as their state of incorporation, and by virtue of this fact become subject to Delaware corporate law unless overridden in any respect by federal laws or regulations.

16. See also Olcott v Tioga R.R. Co., (1863) 27 N.Y. 546 (Court of Appeals of New York); Charleston Boot & Shoe Co. v Dunsmore, (1880) 60 N.H. 85 (New Hampshire Supreme Court).

17. Although § 141(k) of the Delaware General Corporation Law vests a company's shareholders with the collective power to dismiss the board without contractual cause, this power is granted on a reversible-default basis only. As such, it is expressly provided to lapse if the relevant board is ‘classified’. This term denotes a common governance practice in US corporations whereby the board of directors is divided into three separate classes for the purposes of periodic retirement and reappointment, with the effect that each year one-third of the board will automatically stand for reappointment. Since the vast majority of US corporations opt as a matter of commercial custom to classify their boards, the shareholders’ default right under Delaware law to ‘fire’ the board without cause is typically excluded (in effect at the behest of management) under the terms of the corporate constitution. This means that, for all practical purposes, the boards of most US public corporations are irremovable by shareholders during the course of their (normally three-year) period of office.

18. Admittedly, in recent years the powers of shareholders in US corporations have been increased incrementally vis-a‘ -vis directors at both (Delaware) state and federal level, in particular following the introduction of SEC Exchange Act Rule 14a-8 allowing shareholders of US-listed corporations in certain (limited) circumstances to have proposals included on the company's proxy card (albeit expressly excluding proposals relating to directorial nominees) to be subsequently voted on in the annnual shareholders’ meeting. By virtue of recent SEC rule reforms proposed under the auspices of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, moreover, it is expected that shareholders of US-listed corporations will soon have a further right (under heavily limited circumstances) to propose their own board nominees for inclusion in the company's proxy materials. However, even taking into account these important amendments to the traditional US proxy process, the basic position remains that shareholders are (and will continue to be) in the ordinary course of things placed by US law in the position of (secondary) decision-approvers, rather than primary decision-makers.

19. For an influential defence of this position (somewhat ironically) on the basis of contractarian logic, see Bainbridge (2008, especially ch. 1).

20. This is by virtue of Article 3 of the ‘default’ Model Articles of Association applying to both private and public companies registered in the UK, as set out in the Companies (Model Articles) Regulations 2008 (SI 2008/3229).

21. On this, see the UK Companies Act 2006, section 33; Nolan (2006).

22. See Companies Act 2006, section 21.

23. See Companies Act 2006, section 168.

24. This power is established by article 4 of the Model Articles for private and public companies, on which see supra, note 20.

25. On this, see Parkinson (1993, pp. 54–5).

26. See, in particular, section 168(5) of the Companies Act 2006; Keay (2007, pp. 673–5).

27. On this point, see Lazonick and O'Sullivan (2000).

28. For supporting governmental recommendations to this effect within a UK context, see Walker (2009, ch. 7).

29. On this legal quality of the Anglo-Saxon employment relation generally (as discussed within a UK context), see Deakin and Morris (2005, p. 121).

30. On the propensity of financialized corporate governance to engender continual corporate restructuring, see Froud et al. (2006) and Ireland (2009).